Discover's shares were up 5% year-to-date through Tuesday's close, following a 63% return during 2012. But "the valuation still does not give credit for the true franchise value and the proven strength of the management team," Napoli wrote. A quick look at Discover's very strong earnings performance illustrates just how low the forward price-to-earnings ratio is. For fiscal 2012 ended Nov. 30, the credit card lender reported net income available to common stockholders of $2.3 billion, or $4.47 a share, increasing from $2.2 billion, or $4.06 a share, the previous year. The company's return on average assets (ROA) was 3.23% in fiscal 2012, and its return on average tangible common equity (ROTCE) was 26.8%, according to Thomson Reuters Bank Insight. With its focus on credit card lending, Discover's ROA has ranged from 1.20% to 3.43% over the past five fiscal years, while the ROTCE has ranged from 12.7% to 26.8%. During that period, the "weak year" for ROTCE was fiscal 2010, when Discover set aside $3.2 billion for loan loss reserves. The low forward P/E ratio puts Discover's stock at a similar valuation to the "big four" U.S. banks, which lack Discover's focus on credit card loans. Such loans made up 82% of the Discover's loan portfolio as of Nov 30.
- Shares of Citigroup(C - Get Report) closed at $43.60 Monday, trading for 8.4 times the consensus 2014 EPS estimate of $5.20. Excluding 2008, when Citi lost $27.7 billion, the company's ROTCE has ranged from negative 1.33% to 8.04% over the past four years, according to Thomson Reuters Bank Insight.
- Bank of America(BAC - Get Report) closed at $11.55 Tuesday, trading for 9.0 times the consensus 2014 EPS estimate of $1.29. The company's ROTCE over the past five years has ranged from a negative 1.75% to 8.20%.
- JPMorgan Chase(JPM - Get Report) closed at $49.49 Tuesday, trading for 8.5 times the consensus 2014 EPS estimate of $5.82. The company's ROTCE over the past five years has ranged from 6.89% to 15.26%.
- Shares of Wells Fargo(WFC - Get Report) closed at $35.88 Tuesday, trading for 9.2 times the consensus 2014 EPS estimate of $3.89. Wells Fargo has had the best earnings among the big four, with ROTCE ranging from 8.97% to 18.02% over the past five years.
Despite his upgrade, Napoli believes Discover is "overearning." He points to "credit losses at an all-time low and margins at attractive levels," and believes the company will build its loan loss reserves over the next several years. The analyst estimates that Discover will earn $4.56 during fiscal 2013, with earnings declining slightly to $4.50 in fiscal 2014, declining further to a "normalized" level of $4.23 in fiscal 2015.